Friday, May 14, 2010

Financial Innovation

Matt Yglesias writes:
So the question for people who worry about stifling financial innovation in the past, the question is what problem are you hoping more innovation might solve? “Interest rates on mortgages are much higher on the west coast than on the east coast” reflected a concrete problem with the then-extant financial markets.

He was riffing off Ryan Avent, who writes:
if we can't quantify the extent to which there are net benefits to innovation, then it's hard to see that this argument is based on anything other than blind faith.

Now, I realize that both these are trying to examine a key point in the argument against financial regulation generally, which is to say it stifles innovation. I think Ryan's motivations are more pure than Matt's, which is to say I think Matt has largely become a partisan hack since moving his blog over to Think Progress. Ryan, I think, is just asking a question for the purposes of cost-benefit analysis. To quantify it.

But here's the problem -- we don't know what benefits future innovations will bring. To put it in terms most people can more easily understand. In 1970 or 1980 or even 1990, the idea that something like an iPod could exist was entirely science fiction. Same for the Internet and all sorts of technological innovations. That's kind of the entire point of innovation; it's entirely new. Consequently, trying to determine some quantification for the benefits of it is impossible. We can't discuss the benefits of something nobody's ever thought of yet.

A fair criticism, and one that Matt makes pretty explicitly, is what problems are there in the financial markets that we actually need to solve? Haven't we solved most of the big problems already; therefore, aren't we taking on risk for less and less benefit? But isn't it pretty common that most people never thought that there was a need for an invention before it was invented. So, it's not really blind faith, as Ryan argues, but an assumption based on historical evidence that human beings find better and better ways of doing things over time. That there's inevitable progress in all fields of human endeavor. Ironic that a self-proclaimed progressive, like Matt, would doubt the potential for progress.

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